While a Utility May Be Failing, Its Owner Is Not

Pacific Gas and Electric, the giant California utility, may have just made one of the largest bankruptcy filings in history, but it has been a banner year for the rest of its parent company, the PG& E Corporation.

In Bethesda, Md., far from the energy crisis in California, another PG& E subsidiary, National Energy Group, earned $162 million last year and ranked as the nation's third-largest power trader. Compensation for the unit's executives soared. Many investors now believe that the subsidiary, just a decade in the making, is by itself worth more than its 96-year-old utility sibling.

How did National Energy get so big so fast? By using cash, partly generated by its sister utility, to buy unregulated power plants in the Northeast, expand trading-floor operations and sell power across the country. The exact numbers are in dispute, but much of Nationals Energy's profits last year came from California.

Most other large utilities have done the same thing over the past decade, building national or even global power companies from roots in local monopolies. But nowhere is the success of these unregulated businesses more of an issue than in California, where PG& E's investments may be challenged in bankruptcy court.

And today, the offspring of the nation's utilities dominate that market, after industry leader Enron. Eight of the nation's 10 largest power marketers are affiliates or spinoffs of regulated utilities, controlling about 42 percent of power trading.

It is largely these unregulated power producers and traders whose sales of power in California have prompted accusations by state leaders of price gouging, and demands for the price caps that federal regulators took their first, halting steps toward embracing last week.

The profitability of the utilities' unregulated operations is becoming clear as companies report earnings for the first three months of the year.

For example, Reliant Energy reported that operating income at its unregulated wholesale energy business soared to $216 million in the first quarter, or 16 percent more than at its regulated utility, which serves Houston. This week, Reliant expects to spin off its unregulated businesses through an initial public stock offering that would put a market value on the new company of as much as $8.8 billion -- more than the rest of Reliant.

A number of other major utility companies have spinoffs or trading and generation units that now earn nearly as much as, or more than, their core utility operations. These include Duke Energy in Charlotte, N.C.; Sempra Energy of San Diego; the Southern Company in Atlanta; the Constellation Energy Group in Baltimore; and Utilicorp United in Kansas City, Mo.

In some places, the growth of the unregulated businesses continues to raise questions of fairness -- particularly where utilities have been permitted to transfer plants to the new units at deep discounts to their market value. Critics say that ratepayers, whose bills paid for the plants' construction, should benefit more when the plants are sold.

In Florida, a commission on energy deregulation formed by Gov. Jeb Bush has proposed permitting such transfers on the grounds that they are needed to create a new wholesale marketplace. Opponents, including the Florida Municipal Electric Association, which represents utilities owned by local governments, say the plan would produce a $9 billion windfall that should go to ratepayers.

In California, some creditors of Pacific Gas and Electric have signaled that they will want the bankruptcy court in San Francisco to review parent PG& E's efforts to keep its unregulated businesses out of creditors' reach.

And the California Public Utilities Commission is investigating whether PG& E and Edison International, whose Southern California Edison utility unit is also near insolvency, have improperly transferred cash to their parents and to unregulated sister companies.

A recent audit ordered by the commission showed that Pacific Gas and Electric transferred $4.1 billion to PG& E from 1997 to 1999. Most of that went to dividends and stock repurchases, but $838 million was invested in other subsidiaries, primarily its National Energy Group unit. Southern California Edison transferred $4.8 billion to its parent company between 1996 and November 2000, a separate audit showed; Edison International invested $2.5 billion in its unregulated Mission Group subsidiaries during the same period.

Executives of the companies say the transfers were proper. Audits have shown that ''we followed the rules and didn't do anything wrong,'' said PG& E's chief executive, Robert Glynn. ''We did not ask consumers in California to support any of the losses that occurred in those businesses when we started them up,'' he said. Now, forcing the unregulated units to support their ailing sister utility, he said, ''would be no different than calling up shareholders and saying, 'The California electric bills are pretty high; send some money in so we can give it back to them.' ''

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Loretta Lynch, the president of the utilities commission, took a different view. ''Should we look backward,'' she asked, ''and say, 'Hey, wait a minute -- that corporate structure profited by all of our power payments to them in the past, and they should participate in helping us through to get to a solution in the future?' ''

The cornerstone deal of PG& E's unregulated energy business was struck four years ago, when it acquired the hydroelectric and fossil-fueled generation plants of New England Electric System for $1.6 billion. PG& E is now one of the largest generators in the Northeast, operating plants that can light up to five million average-sized homes.

While California officials say Pacific Gas and Electric's woes have been caused, at least in part, by market manipulation by out-of-state generators, the Justice Department has been investigating possible market abuses involving PG& E and two other companies in New England. Mr. Glynn said that PG& E had done nothing wrong and that the company has responded to Justice Department requests for information.

Overall, PG& E's National Energy Group has 30 power plants in 10 states, and others under development or construction that include one in Athens, N.Y., that is expected to begin supplying electricity to New York City in 2003. It also operates an energy trading operation in Bethesda and controls a natural gas pipeline into Northern California.

To Wall Street, the utility companies' investments in unregulated businesses were a necessary survival tactic, as investors demanded faster-growing profits.

''The stock market was going like gangbusters, and the utilities' returns of 11 percent weren't cutting it,'' said Richard Cortright, a utility analyst at Standard and Poor's, the bond rating agency.

Moreover, as deregulation loomed, industry executives saw no choice but to make new investments. ''It looked like the utility opportunity was going to start shrinking,'' Mr. Glynn said.

Consumer groups question whether utilities would have invested more in improving basic service if they had not had the option of putting money elsewhere.

Mike Florio, a lawyer with The Utility Reform Network, a consumer group in San Francisco, cited findings last year by state regulators that from 1987 to 1995, Pacific Gas & Electric spent nearly $550 million less on maintaining electric and gas facilities than had been factored into its rates. Separately, in 1999, the utility agreed to pay about $29 million to settle charges that consumers were endangered because it failed to trim trees near high-voltage power lines.

''Several hundred million dollars didn't get spent for maintenance, and that ultimately falls to the bottom line as profit,'' Mr. Florio said.

Mr. Glynn said the utility had always spent appropriate sums on maintenance, coming within one-half of one percent of the amount built into rates over a 20-year period.

In the big picture, he said, it was hard to see how PG& E had been a winner in deregulation, even before its utility's humiliating bankruptcy. ''If you look at what happened, the net of it was a loss,'' Mr. Glynn said, ''because the value leaked out on the regulated utility side faster than we were able to build it on the nonregulated side.''

About This Report

This article is part of a joint reporting effort with the PBS series ''Frontline,'' which will broadcast a documentary about California's energy crisis on June 5.

Correction: May 2, 2001, Wednesday A headline on Monday with the continuation of a front-page article about the growth of unregulated power generation and trading businesses like those owned by the PG&E Corporation misstated the company's financial condition. A bankruptcy filing by the company's Pacific Gas and Electric utility unit has hurt PG&E's stock price and financial health. While PG&E's businesses outside the utility unit are doing well, the company as a whole is not ''thriving.''